Loan Servicing Valuation Model
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Dictionary of Terms
All or None: in a trade situation--means you must trade entire amount.
Arbitrage: the process of buying securities at one price and simultaneously selling them at another to take advantage of the difference in purchase and sale prices.
At-the-Money: used in dealing with options when the strike price is equal to the market price on the underlying security.
Average Life: the average number of years that the principal balance of a mortgage security will be outstanding.
Ax: specific securities transaction that a dealer wants to execute; if a dealer has an "ax," a lender can usually get better prices.
BE Yields: Bond-Equivalent Yields--adjustments made to yields on mortgage securities so they can be compared to corporate and Treasury bond yields.
Baby Pools: PC Pools with prefixes of 43 through 48 representing 30-year and 15-year Guarantor Securities with original balances of $250,000-$1 million.
Bear Market: a market condition where securities prices are declining.
Bid Price: the price at which a mortgage lender can sell securities.
Bid-on-the-Roll: strategy used to accommodate an earlier than expected PC formation where the settlement date is moved closer to the trade date.
Bid/Offer Spread: difference between the price where a dealer stands ready to buy a security and the price where a lender will sell a security.
Bond: an interest-bearing certificate of debt with a fixed maturity date.
Book-entry: a method of owning a security comparable to credit in a bank acount, as opposed to having a physical piece of paper. This is accomplished by an electronic registration and transfer system which enables the rapid and accurate transfer of securities with simultaneous cash settlement in federal funds.
Bull Market: a market condition where securities prices are rising.
Call Option: option that grants the buyer the right, but not the obligation, to buy a security at a particular price on a particular date.
Cash Flow: represents the principal and interest payment to investors.
CMO: Collateralized Mortgage Obligation--a type of pay-through bond that provides for cash flows generated by the collateral to be partitioned to create different maturity classes, called tranches.
Coupon: the contract interest rate on the face of the note or bond; the rate of the security will be less than the rate of the underlying mortgages.
Correspondent: used to describe a mortgage bank that services mortgage loans as a representative for the owner of the mortgage or investor. This term also applies to the mortgage banker's role as originator of mortgage loans for an investor.
Covered Options: when an investor owns underlying securities on which options are written.
CPR: Constant Prepayment Rate--a measure of the prepayment rate of a mortgage backed security.
CUSIP Number: a nine-digit number assigned by the "Committee on Uniform Security Identification Procedures"; required to identify a PC pool.
Definitive Security: the paper form or certificate used to represent a security. Since book-entry was established, most Freddie Mac securities no longer exist in definitive form.
Discount: a price below par--i.e., when a security has a price below par it is at a discount.
Dollar Roll: the sale of mortgage securities in the current month and simultaneous purchase of similar securities in a forward
Duration: a measure of interest-rate risk on a fixed-income security.
Dwarfs: a FNMA pass-through security with a 15-year original term.
Early Funding: the process whereby a Guarantor customer swaps mortgages to Freddie Mac for PCs, agrees to forward sell the PCs, and receives the sale funds before the normal settlement date instead of having to wait for a security to be formed.
Face (amount): the original par amount (dollar balance) of a security.
Fail: when either party in a securities transaction does not fulfill its obligation; usually involves delivery of a security after the agreed settlement date.
Factor: the percentage of the original par amount outstanding at the end of a given month; the factor equals the current balance divided by the original balance.
Fill or Kill: a market order to execute a transacation immediately at a particular price ("fill") or else the order is withdrawn("kill").
Firm Price: the price at which a dealer stands ready to buy or sell a security.
Forward Sale: when a securities sale is made, often before the securities have been formed, but will not settle until some future date, usually from one to four months later.
Gnome: a 15 year security that is originated by Freddie Mac.
Good Deliver: seller's strict compliance with rules regarding the delivery of their mortgage-backed securities to the purchaser.
Half-Life: the time period that has elapsed when 50% of the mortgage principal balance supporting a pool has been repaid; occurs when factor equals .5.
Hedging: a strategy used to protect against adverse price changes due to fluctuating interest rates--usually means equating a balance between a long position and a short position.
I.O.: Interest Only--used to describe a stripped mortgage-backed security that is comprised of interest and no principal.
Indication Price: a dealer's estimate of the market price on a particular type of security.
In-the-Money: describes a market condition when the strike price on an option is lower than the market price.
Intrinsic Value: the extent to which the option conveys the right to buy or sell the underlying security or a better price than the current market price.
Inventory: the time period after a loan is closed and before it is sold in the secondary market.
LIBOR: London Interbank Offered Rate--rate at which multinational banks dealing in Eurodollars in London charge each other for large loans; one-, three-, and six-month LIBORs are used as indices for determining floating rate coupons, with the three-month rate being the most commonly used benchmark.
Liquid Securities: securities that frequently trade and have narrow bid-offer spreads.
Long: the act of purchasing a security.
Long Bond: the most recently issued and most widely traded current 30-year treasury bond.
MCF: Mortgage-Cash Flow--security with a structure similar to a CMO, but loans are not segregated on the books of the issuer.
ME Yields: Mortgage-Equivalent Yields--the yield on an instrument paying monthly cash flows to the investor.
Midgets: a GNMA pass-through security with a 15-year original term.
Mortgage-Backed Securities: pass-through securities representing an undivided interest in a pool of mortgages or trust deeds; principal and interest payments on underlying mortgages are used to pay principal and interest on the securities.
Motorcycle: also referred to as "GMC," Guaranteed Mortgage Certificate. As forerunner to the CMO, GMCs convey the monthly principal and interest payments on mortgage collateral into a series of semiannual interest payments of principal. The issuer also guarantees a schedule of minimum principal reductions.
Netout: when the difference between cash owed by two parties is only paid by the party who owes more.
Naked Options: when an investor sells options on securities they do not own.
Non-Gnomes: Freddie Mac Guarantor PCs representing an undivided interest on a pool of 15-year original-term mortgages.
Notification Date: date that option buyers must notify sellers whether or not they will exercise the option.
Offer Price: the price at which a lender buys securities.
Offer On-the-Roll: a strategy commonly used to avoid fails which results in moving the settlement date farther into the future.
Open Order: an agreement between a lender and dealer that a trade can be executed if a certain price can be obtained for the lender. The order is left open with a dealer for a specified period of time.
Option: the right, but not the obligation, to buy or sell a security at a specified price on a specified date.
Origination: a new mortgage loan.
Out-of-the-Money: describes a market condition when the strike price on an option is higher than the market price.
Pair-Off Fee: the fee charged for the failure to fulfill a forward commitment to sell; the fee is determined by the cost of the buyer to purchase similar securities at the time of the pair-off, plus any processing expense.
Par: the face value of the mortgage (or bond) principal--equals its actual selling price that is with no discount or premium.
Par Compression: tendency of the price of premium coupon mortgage securities to rise at an increasingly slower rate as interest rates decline.
PC: Participation Certificate--a mortgage pass-through security issued by Freddie Mac.
PC Pool: the group of mortgages that compose the collateral of the PC security.
PC Pool Number: a six-digit number uniquely identifying a PC security; used for trading purposes.
PC Pool Prefix: the first two digits of the PC pool number; used to identify the general characteristics of the mortgages in a PC pool.
Pipeline: loan applications that a lending institution holds until they are closed.
Pipeline Fallout: when a loan application is made, but not closed, it is said to "fall out" of the pipeline.
Plus: 1/64th of one percent of a dollar price of 100 or par.
P.O.: Principal Only--used to describe a type of stripped mortgage-backed security that is backed by principal only, not the interest on the mortgages backing that security.
Point: an amount equal to 1% of the par amount of a security or mortgage.
Position: the net difference between a lender's buy and sell position in a security.
Premium: a security trading at a price in excess of par (100).
Price Run: indication prices for the most liquid securities.
PSA: Public Securities Association--an organization that provides information on mortgage-related and government-sponsored securities.
Put Option: the right, but not the obligation, to sell the underlying security at a specified price on a specified future date.
Reg Date: specific settlement days established by PSA each month to help expedite and standardize trading.
REMIC: Real Estate Mortgage Investment Conduit--created by the Tax Act of 1986; a vehicle for issuing multiclass mortgage pass-through securities which offer both issuers and investors certain tax and accounting advantages. A REMIC structure allows the issuer to remove the securities as liabilities from the balance sheets for financial reporting purposes; for investment purposes, REMIC securities closely resemble CMOs and are usually issued with short, intermediate, and long maturities.
REPO: Repurchase Agreement--an agreement to purchase mortgage securities from a party with a simultaneous agreement to resell them to the same party at a specified future date and price. (A way of financing.)
Settlement: the exchange of securities for cash between buyer and seller.
Shorting the Market: to sell a security which is not owned by the seller.
Split-Fee Option: the right, but not the obligation, to buy an option (generaly a put) for a specified premium on a specified future date; also called a compound option, an extendable option, or a call on a put or call.
Straddle: type of options strategy that involves buying or selling both a put and call on the same security with the same expiration date and same strike price.
Strike Price: the price at which the option seller has agreed to buy or sell securities--also called the exercise price.
Strips: a type of security that is formed by separating principal from interest; the resulting securities can have varying proportions of principal and interest or can be formed using interest only (I.O.) or principal only (P.O.).
Swap: exchanging mortgages for PCs representing interests in those same mortgages under Freddie Mac's Guarantor Program.
TBA: To Be Announced--a trade made in anticipation that a pool will be formed.
Tail Piece: the dollar amount in excess of an even million; e.g. $200,000 is the tail piece of the amount $5,200,000.
Tick: 1/32nd of one percent of the original face value of a security.
Tolerance Levels: also referred to as "tolerance"; the specified amount above or below which a delivery will be accepted; e.g., if a TBA trade is done on a $1,000,000 trade, there is a plus or minus delivery tolerance level of 2.4999 percent on the security--meaning that a seller can deliver anywhere between $975,000.01 to $1,024,999.99 and still be making a "good delivery" to the security purchaser.
UPB: Unpaid Principal Balance--the amount of principal that is still outstanding on a security.
Underwater Loans: mortgages with below book-value rates.
WAC: Weighted Average Coupon--information provided by lenders in order to give a clearer picture of the mortgages backing a security.
WAM: Weighted Average Maturity.
WARM: Weighted Average Remaining Maturity.
"We're Done": the expression confirms that a contract has been concluded between buyer and seller.
Window Date: also referred to as the extension date or first expiration date. The date that the holder of a split-fee option must notify the writer of his intention to exercise his right to buy the underlying option.
Writer-of-Options: seller of an option.
Yield: the internal rate of return on a mortgage-backed security.
Yield Curve: a graphic display used to show the yields of a specific
financial instrument with various maturities. A two dimensional graph which
displays yields of a specific financial instrument on the vertical axis
and maturity on the horizontal axis.